How Do You Become Part of the One Percent?
Try to save something while your salary is small; it’s impossible to save after you begin to earn more. — Jack Benny, American Comedian
As Mitt Romney poises himself for another run at the White House, the debate about the one percent and the 99 percent is bound to return. Luckily the income gap issue has been solved and everyone is rich now, which is why Americans are buying more luxury goods than ever and choosing to “mega-commute” in their luxury SUVs, which were the top-selling vehicles in 2014.
Wait, you’re telling me that not everybody is as wealthy as the Romneys? That even as wages rise and prices fall, we’re still saving less money than at any point in American history? How is that possible?
I think it comes down to the way we talk about money and wealth in the United States. We seem to focus exclusively on maximizing our income instead of accumulating actual wealth. It doesn’t help that every news source defines the American wealth gap as those who make more and those who make less, forgetting that salary is only one part of a person’s wealth.
As you might guess, thinking of our wealth exclusively in terms of income has a pretty damaging effect on our finances. By using income as our only measure of wealth, we place greater importance on spending than saving, setting ourselves up for financial failure. To escape this trap, we need to understand what’s causing this misunderstanding and what to do about it.
One problem is that we want to keep up with the Joneses, but it’s very difficult to judge how wealthy the Joneses actually are based on appearances alone. When we see our coworker Daniella with a new car, we can guess how much she spent, but we don’t know whether she emptied her bank account to buy it. Easy access to credit makes it even more difficult to tell if Daniella is rich. Did she buy the car in cash, or is she stuck with car payments for the next five years?
Another problem with salary is that it tends to swing wildly from year to year. In fact, 1 in 8 people have been part of the one percent at some point in their lives without realizing it. Our salaries tend to increase over time, but not evenly, and our spending grows just as quickly because of our focus on the Joneses. When we compete to see who can earn and spend the most money, we end up saving none. In good times we spend our money on big cars, fancy vacations, and cable TV. In bad times we foreclose on our homes, rack up consumer debt, and spend more.
“No biggie” you might respond, “I don’t care about the future. Bring on the debt and the luxurious lifestyle that goes with it!” Well, the problem is that if everyone’s in debt, then there’s nobody with extra money to lend, let alone to invest. One day your credit card company (and the nation of China) will realize that Americans are never actually going to pay them back. Believe me, you don’t want to be anywhere near Wall Street on that day, and your days of luxury debt will be over.
But don’t despair. There’s a way to keep America moving, keep us all happy, and save adequately at the same time! We can avoid falling into the traps set by our spendy neighbors by understanding the number that really matters when determining our wealth: the savings rate.
You’ve heard it before and you’ll hear it again: Your savings rate is the single most important number you have when determining your chances for upward mobility. Real quick for new readers, the savings rate is the percentage of your take-home income that you save. So if you earn $50,000 and you save $5,000, you have a ten percent savings rate. Easy enough, but how does it benefit us when we think of money in percentages?
You can ask yourself the question, “How many years can I go without a salary if I save x percent?” If you save 10% of your take-home pay, you can take a one year vacation every nine years without going into debt. If you save 20%, you can take one year of vacation every four years. If you save 50%, you can be on vacation every other year. Woah, that’s starting to look exponential! That’s because it is! And what about when you save 75% of your income? You only have to work one year before you can take a three year vacation. Yes, you read that right.
See why income isn’t the magic determinant of wealth we make it out to be? Sure, it’s an important factor, but the most important factor by far is how much we save. The real kicker is that the simple change of perspective from “How much do I make?” to “How much do I save?” could be all it takes to help everyone feel like we’re part of the 1%. It doesn’t matter if you earn more or less than the Joneses. If you have a higher savings rate, you’ll beat them in the long run in terms of both money and time.
So I’m going to issue a formal challenge to my readers. Save 50% of your income. This modest achievement will easily rocket you into the top echelon of savers. If you’re tempted to respond with “I can’t, because…” then I challenge you to instead ask, “how can I?” That being said, I want you to use that gut reaction to your advantage. Go on, make a list of all the reasons you can’t save 50% of your income.
Now take each of those items and turn them into “how can I?” questions. If you’re unsure how to start, write down a list of all the things you would need to do to achieve a 50 percent savings rate. Will it require you to downsize homes or only eat seasonally fresh foods? Will it require hosting fun activities at home instead of at the bar? It likely won’t be easy or happen overnight, but by using the incredible pink squishy thing between your ears you’d be surprised what becomes possible.
Nathan is the CEO of Monte Largo Financial Advisors LLC.